Reading The Annual Report

FINANCIAL REPORTING AND ANALYSIS
Reading the Annual

Report
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Learning Objectives
After going through this chapter, you will gain a basic understanding of :
Importance of Annual Reports

Structure of Annual Reports
Chairmans Statement
Management Discussion and Analysis (MD&A), including:
-
Utility of information in MD&A

Discussion of operational factors and developments in the marketplace for the
companys products
Understanding opportunities and threats
Growth analysis
Basic overview and understanding of acquisitions
Operational developments
Opportunities and threats
Understanding growth rates
Financial strategies
Mergers and Acquisitions (M&A)
Learning Objectives
Financial Statements
- The Income Statement
- Balance Sheet
- Cash Flow Statement
Notes to Consolidated Statements

Report of Management's Responsibilities
Risk Factors
Legal Proceedings
Report of Independent Auditors
Directors and Officers
Significance
An annual report is a formal report on a companys performance in the preceding year. A
public company produces an annual report for its stockholders, the people and
institutions that own the company. Other interested parties, such as employees,
customers and potential investors, read this report, too.
An annual report is one of the most important documents a company produces and is
often the first document someone consults when researching a company. It reports how
the company did financially and often explains the scope of its business mission and
management philosophy.
Significance
Some points of paramount importance of annual reports are:
Decision-making tool for investors
Annual reports are the most effective tool to assist investors. They contain a wealth of data to
aid the investor in evaluating financial situation, corporate value and risk. Annual reports
provide valuable insight into management philosophy as well as a sense of what the company
is about. Financial analysts often calculate representative ratios based on accounting data in
the annual report and recommend clients to buy, hold or sell the shares in a company.
Investors and financial analysts often keep annual reports for many years and the value of the
company is determined by this document.
The annual report is one of the most important sources of investor relations. It is one of the
tools available to investors that help them build a better understanding of a company.
Significance
Corporate information source
The annual report is the most important source of corporate information. It is the first source
consulted by stakeholders when searching for information. It is usually the starting point for
any company research. Annual reports provide detailed financial information about a company
in a standardized format. The result is easy comparison of companies and effortless location of
specific information. The standards to which annual report information must adhere are
nationally defined and enforced by law.
The annual report briefs shareholders on key financial news relating to the company. It further
provides an abundance of valuable information that enables an investor to better understand
the company investigated. It is the most believable source of investment information because
it is governed by legal and regulatory rules requiring full disclosure to shareholders.
Significance
Companys communication tool
An annual report provides a means for the enterprise to communicate effectively with the
companys shareholders and other stakeholders such as investors and analysts. Besides
financial information, companies also use annual reports to communicate the past actions of
the company, the results of those past actions, intended future actions and issues of major
strategic importance for corporate performance.
Significance
Company Marketing tool
An annual report is part of the corporate communication strategy that pursues strategic
objectives, such as strengthening the corporate image or brand. Annual reports can be useful
in recruiting employees and introducing the company to new or potential customers. The
annual reports educate investors and project a company in a positive context.
Over the years the annual report has changed from a plain statement to an increasingly glossy
product containing maps, charts and pictures in a multi-colored production designed to have
mass appeal.

Annual reports generally include the following sections:
Annual Report
Chairmans Statement / Letter to stockholders

Financial highlights
Management's Discussion and Analysis [MD&A]
Risk Factors
Legal Proceedings
Report of Independent Auditors
Directors and Officers
The Income Statement

Balance Sheet
Cash Flow Statement
Company Annual Reports typically commence with the Chairmans Statement (CS), also called a
letter to shareholders. This is followed by Management Discussion and Analysis (MD&A). These
are followed by detailed financial statements.
10

As is evident from the diagram below, the level of detail (with respect to the information provided)
increases as we progress from the CS to the financial sections / numbers.
Birds Eye View
Elaborates the above and

provides further information
Detailed Numerical
Snapshot of Performance
11

While CS and MD&A sections do not focus primarily on numbers, you must nevertheless note that
the CS + MD&A and the financial statements together constitute an integral whole - in other words,
solely relying on either of the two will lead to erroneous conclusions in ones analysis.
12

Another aspect of the CS + MD&A is that they contain both facts and opinions (unlike financial
statements, which contain only facts). It is important to sift facts from opinions and then come to
independent conclusions about the opinions. Opinions typically concern companies expectations
with regards to growth prospects, their expectations with regards to the overall economy, etc.
Chairmans
Statement
Contain both facts

and opinions
Management Discussion
& Analysis
Numbers
Contain only facts
13

In this process, a company also provides insights into its key strengths and weaknesses, challenges,
success factors for its industry, etc. Also, going through these two sections will leave you with a
clear framework to tackle the financial statements (which always follow the CS and MD&A). This
chapter also tries to show you how the CS and MD&A link up with the financial statements.
At this stage, it is sufficient to have a clear grasp of the companys strategies. However, for the
analysis to be thorough, it is necessary to understand whether these strategies are appropriate for
the company, how they stack up vis--vis strategies adopted by competitors and the risks / rewards
associated with each strategy.
14

Note that one of the objectives of going through the CS+MD&A is to arrive at a set of questions
which will provide you with a platform to take your analysis to the next level. These sections,
while providing you an insight into company strategies and performance, will not provide you
with 100% of the needed information / understanding.
15
Chairmans Statement (CS)
While there is no regulatory requirement for companies to provide CS, companies do so because
they use this to communicate with their shareholders. Although this section is also useful to
bondholders, employees, analysts, etc., this is primarily aimed at shareholders.
Chairmans
Statement
Primarily
Shareholders
Communicates with
Bondholders,
Also useful to
Employees,
Analysts,
etc.
16

This section sums up the past years performance in broad terms and lays out the thrust / strategy
for the companys future (This typically springs from the companys past performance). This in turn,
affects the companys future. A schematic representation is given below:
17
This section generally does not contain too many details and does not get into specifics such as
market share increase, etc. A reading of this section should clarify areas such as which sectors /
products the company proposes to focus on, whether growth will be organic or inorganic (i.e. by
acquisitions) going forward, as well as potential diversification strategies and entry into / exit from
businesses, etc.
18
An example
Excerpts from Tata Motors Limited 62nd Annual Report 2006-07
Dear Shareholder,
The Indian economy continued its trend of robust growth on the back of strong performance in
key industrial sectors. While inflationary concerns during the year have prompted a correction in
interest rates, which could lead to a slowdown in consumer demand, the fundamentals of the
economy continue to remain strong and the long-term outlook for the economy continues to be
positive.
Salient point: Continued good performance of the economy.
19
An example
The Indian automotive industry, after experiencing a slow-down in growth rate last year, bounced
back impressively this year to post strong volumes in all segments. In particular, the commercial
vehicles segment, which saw a decline in growth rates over the last two years, grew by 33%,
buoyed by increased industrial activity and continued investment in road infrastructure. The
passenger vehicle segment was favorably impacted by a reduction in excise duty on small cars
and increased consumer spending.
20
An example
In this scenario, Tata Motors has had another outstanding year. The Company out-performed the
industry with record revenues and sales volumes. It significantly improved its market share in
commercial vehicles, driven by the enormous market acceptance of the Ace 0.75-tonne pickup
vehicle.
Salient point: Continued good performance of the company.
21
An example
The Company also achieved its highest-ever sales volumes of passenger cars and utility vehicles
during the year.
The Company has, over the past few years, followed a conscious strategy of expanding its
product range and its geographic spread in order to reduce its dependence on one single
economy and one single business cycle. This has led to the development of new products such
as the Ace in the case of commercial vehicles, and the proposed small car, apart from serious
expansion of exports and/or assembly activities in overseas markets.
Salient point: Medium-term focus on increasing product range largest roll-out in the history of the
company.
22
An example
As a result of this strategy, the Company has formed a joint venture in Thailand to assemble and
market pick-up trucks in the Thai market, which is the second largest pick-up market in the world.
The Company has also entered into a joint venture with the Brazil-based Marcopolo Company, to
manufacture and assemble fully built buses and coaches in India. The Company has achieved
great visibility in the passenger car markets in South Africa, Spain and Italy. It is now proposed
that the vast markets of Latin American countries be jointly addressed with the Fiat Group, as part
of the global alliance between the two companies.
Salient point: Focus on increasing geographic footprint.

Points to ponder: How large are the joint ventures that the Chairman is talking about are these
merely feel-good statements / hopes or are these financially significant? Is this true for exports
also?
23
An example
During the year, construction of the new manufacturing plant (jointly owned with Fiat) at Ranjangaon
has been progressing on schedule and will go on-stream in 2008. The Fiat relationship has further
been strengthened through the execution of a Memorandum of Understanding with Iveco (the Fiat
Groups commercial vehicle company), to explore opportunities for cooperation in engineering,
manufacturing, sourcing and distribution of products, aggregates and components of commercial
vehicles across markets. FIAT has also signed a licensing agreement with the Company to build a
pick-up vehicle for sale in the Latin American market.
24
An example
Tata Motors remains committed to launching its new small car in the first half of 2008.
Construction work has commenced at the plant site at Singur in West Bengal. There is
confidence that the Companys presence in Singur will result in the same positive impact on the
communities in the area and in the state that its plants have had on the communities in and
around Pune, Jamshedpur, Lucknow and Dharwad. In addition to the Companys own
investment in Singur, large investments will also be made within the plant perimeter by a large
number of automotive component suppliers and manufacturers who will serve the small car
project. One hopes that the Companys bona fides and high sense of social responsibility will
overcome the misplaced apprehensions and concerns which arose in the early days of the
project.
Salient point: Commitment to small car project.
Point to ponder: What are the financial implications of small car project? (i.e. - the likely capex, how
will it be funded, etc)
25
An example
There continue to be pressures on margins arising from rising prices of raw materials like steel, nonferrous metals, rubber and engineering plastics. These will be partially offset by the cost reduction
initiatives undertaken by the Company. However, the prices of most of these materials continue to
spiral upwards for the second consecutive year and this may impact the Companys profitability
going forward. The hardening of consumer finance interest rates and tight liquidity in the second half
of the fiscal year under review, have already started to have an adverse impact on the automotive
industry. If these trends were to continue, growth in the automotive sector could be adversely
impacted. Despite these bothersome trends, the years ahead for the industry and in particular for
Tata Motors, although challenging, are years of great opportunity. The growth of the Indian market,
the increased sophistication in components suppliers capabilities and global sectoral
competitiveness will result in the establishment of a world-scale automotive industry.
26
An example
The challenge for Tata Motors will be to develop and produce technically-advanced commercial
vehicles and passenger cars of world-class quality for the domestic and overseas markets. An
impressive range of new products is planned to be launched over the next two years. This will be the
most aggressive new product program in the Companys history. The focus has been on innovation
and market leadership. The new Ace goods carrier and its passenger-carrying variants are such
innovative products the first in the industry. Similarly, the small car proposed to be launched at a
price of around Rs. 1 lakh, will be a never-before-undertaken project which will hopefully create a
new paradigm in fulfillment of the aspirations of lower-income segment of the people of India, Asia
and Africa.
27
An example
With intense global competition, the challenges will be great but with the spirit, commitment
and dedication displayed by employees at all levels, these challenges will continue to be met
and overcome. Tata Motors will strive to retain its leadership position in India while being
increasingly recognized internationally as an emerging automobile company in the global
marketplace.
28
An example: Tata Motors Limited 62nd Annual Report: 2006-07

Comment: Note that companies also like to keep some cards close to the chest. For example, Tata
Motors Chairmans statement (FY 2006-07) is silent on the potential for acquisitions it gives no
hint of the future bid for Fords European brands an extremely significant development.
29
Financial Highlights
It consists of key financial statistics for a companys most recent 5 to 10 years period.
An Example
Excerpts from Microsoft Corporation 2007 Annual Report
Fiscal Year Ended June 30
(In millions, except per share data)
2007
2006
2005
2004
2003
$51,122
$44,282
$39,788
$36,835
$32,187
Operating income
18,524
16,472
14,561
9,034
9,545
Net income
14,065
12,599
12,254
8,168
7,531
Diluted earnings per share
Revenue
1.42
1.20
1.12
0.75
0.69
30
An Example
Excerpts from Microsoft Corporation 2007 Annual Report
Fiscal Year Ended June 30
(In millions, except per share data)
2007
3.40
0.16
2003
Cash and short-term investments
23,411
34,161
37,751
60,592
49,048
Total assets
63,171
69,597
70,815
94,368
81,732
8,320
7,051
5,823
4,574
2,846
31,097
40,104
48,115
74,825
64,912
0.35
2004
Stockholders equity
2005
Cash dividend declared per share
Long-term obligations
0.40
2006
0.08
31
Management Discussion and Analysis

(MD & A)
The purpose of MD&A is to provide investors with information that the companys management
believes to be necessary to an understanding of its financial condition, changes in financial condition
and results of operations. It is intended to help investors to see the company through the eyes of
management. It is also intended to provide context for the financial statements and information about
the companys earnings and cash flows.
32

This section, while providing an overview of the companys performance and objectives, goes into
greater detail than the Chairmans Statement. Typical information contained in the MD&A includes
Information on the operating environment such as the state of the market, regulatory changes etc.
Division-wise / product-wise performance
Performance vis--vis the market (i.e. increase / decrease in market share)
The companys own SWOT assessment
33

Company specific factors This could include a host of factors such as labor issues, legal disputes,
etc.
Strategies Strategies which are briefly mentioned in the Chairmans Statement are typically
elaborated in the MD&A. For example, while the Chairmans statement will typically mention various
JVs, the MD&A will go into the operating and financial performance of individual JVs.
Financial information / strategies The level of dividend payouts, potential for share buybacks,
rights issues etc. are also generally covered in this section.
In summary, any factor which materially affects the companys performance is covered in the MD&A.
34

Utility of information in MD&A
It is necessary to clearly grasp all the facts presented in this section in order to understand the
companys performance. While doing so, it is also necessary to see whether there are any
inconsistencies between the CS & MD&A and between the MD&A & financials (for example, growth
rates mentioned in these sections should be in line with those calculated from financial statements).
35

Utility of information: An Example
Excerpts from Marico Limited Annual Report 2006-07
Industry Structure and Development
The Indian Fast moving consumer goods (FMCG) industry is characterized by a well established
distribution network, intense competition between the organized and unorganized sector and low
operation costs. The FMCG market is set to increase from US $ 11.6 billion in 2003 to US $ 33.4
billion in 2015. (Source: www.ibef.org). Penetration level as well as per capita consumption in
most product categories like skin care and shampoo in India is low indicating a large untapped
market potential.
Comments:
It provides information on industry size and growth prospects.

The company is optimistic on future growth because penetration levels are low
(it doesnt give the figures a good analyst should independently verify if this is
true).
36

Utility of information: An Example
Excerpts from Marico Limited Annual Report 2006-07
MARICO Limited Growth Strategy - Sustained Growth

The financial year 2006-07 (FY07) was one of high growth at Marico, as compared to a
compounded growth rate of about 13% during the period from FY02 to FY06. Marico achieved
a turnover growth of 36% during the year, taking its revenue to Rs.1557 crore. While 14% of
this growth was contributed to by acquisitions made by the company, organic growth was 22%.
The company saw significant franchise expansion and thus 20% out of this 22% resulted from
volume led growth.
Comments: Overall growth rate seems to have risen, even after taking into account acquisitions.
(A good analyst will, at this point, make a mental note to delve deeper into the factors behind this
accelerated growth).
37

Operational developments Companies also list out various operational developments that have
occurred during the past year. These portions of the MD&A are mostly factual. This typically covers
the performance of various products / divisions. It could also include a range of developments such
as reorganizations, sale of a division, etc. It is fairly detailed and gives various facts and figures,
including operating metrics. Other information provided could include listing new initiatives taken
during the year, etc.
38

Operational developments: An Example
Excerpts from Marks & Spencer Group plc Annual Report 2006-07
Operational developments
On average, we had 15.8 million visitors to our stores each week and we successfully
encouraged shoppers to buy more each time they visited.
Our TV, newspaper and billboard advertising campaigns are allowing us to project our brand,
one of our most valuable assets, with much greater impact. The key to good marketing is
great product. Now that we have better products, we are using advertising to drive sales with
greater confidence. This year, we extended our television advertising into childrens wear for
the first time.
Note that very few opinions are expressed in this example it mostly consists of facts.
39

2006/07 saw us invest heavily in modernising our stores. 35% of the portfolio was modernised
by Christmas 2006 from big stores such as Cribbs Causeway and Manchester to small high
street stores in Crewe and Clapham. We have a target to complete 70% of the portfolio by the
end of 2007.
This is a big programme. But it is being managed with minimal disruption to customers and our
overall performance. Feedback from customers is good and sales performance at the new
stores is encouraging.
40

We want to offer a convenient, exciting and modern shopping experience. However, our new
stores will only thrive if we keep getting our products and service right. As well as improving
the look and feel of our stores, we have invested in our people, increasing the number of
customer assistants and the amount of time they spend helping customers. Our work on
reward, training and career paths is helping us recruit and retain the best people.
The website, www.marksandspencer.com, performed well, reaching sales of over 100m for
the first time. We know that online is a big opportunity for us and, in March 2007, we launched
our new website the first step in building our multi-channel offer.
41

Our international business also performed well. We have built a strong franchise operation and
now have 219 stores in 34 territories. Turnover, including our eight wholly-owned stores in
Hong Kong and 13 in the Republic of Ireland, rose 16.8% to 610.6m (last year 522.7m)
while operating profits rose 33.2% to 87.5m (last year 65.7m).
M&S Money is benefiting from our partnership with HSBC, with our share of profits more than
doubling from 9.6m to 19.5m. Over three million people now use the &More credit card,
relaunched during the year, and we have over 100 Bureaux de Change at our stores serving
3.8 million customers. We expanded the range of financial products, which now includes home
and car insurance and a new ethical investment fund.
42

Opportunities and threats
Companies typically lay out a whole range of opportunities and threats facing them. The key things
to note while going through this area are to:
First list all the opportunities / threats, and then
Try and get a sense of, which are the most important opportunities and threats.
43

Opportunities and threats: An Example
Excerpts from Tata Motors Limited Annual Report 2006-07
Opportunities
Threats
Road development
Global competition
Car penetration in India
Fuel prices
International business
Input costs
Increase in disposable income
Inflation / hardening of interest rates
Large two-wheeler parc
Government regulations
Growing consumer culture
Growing consumer awareness
Growth of Mass Transport Systems

Comments: The areas in italic are likely the most important opportunities/ threats.
44

Opportunities and threats:
An Example
Tata Motors Limited 2006-07 Annual Report
Comments: Note that there is no one right answer these areas are somewhat open to debate. One
way of trying to figure out which factors are more important than the others is to examine how the
companys performance in past years has been impacted by each of the opportunities and threats
mentioned earlier. Another way would be to look for examples from overseas markets i.e. - to see
how changes in these factors have affected companies that operate in the same industry but in other
geographical locations. Another way would be to see how competitors have been affected by these
opportunities and threats factors.
45

Understanding growth rates
The MD&A contains / is preceded by a snapshot of the companys financial performance. This
enables you to calculate various growth rates. Note that it does not make sense to calculate growth
rates for ratios. Blindly calculating growth rates and viewing them in isolation does not help in
analysis. However, several inferences can be drawn from these growth rates when they are viewed
in relation to each other.
46

Understanding growth rates: An Example
Key growth rates and the inferences that can be drawn from these are given below:
Excerpts from Bharti Airtel Annual Report 2006-07
Full Year Ended March 31
Particulars
Unit
2003
2004
2005
2006
2007
CAGR
Total customer base
000s
3,443
7,141
11,842
20,926
39,013
83%
Mobile Services
000s
3,071
6,504
10,984
19,579
37,141
86%
Broadband & Telephone Services
000s
372
637
857
1,347
1,871
50%
A quick look at the CAGRs tells us the following:
Growth rates are extremely high, in any context.

Rate of increase of customers in the mobile business has far exceeded that in the broadband /
telephone businesses.
47

Particulars
Unit
2003
2004
2005
2006
2007
Total customer base
000s
3,443
7,141
11,842
20,926
39,013
CAG
R
83%
Based on Statement
of Operations
Revenue
Rs. Mn
30,554
50,369
81,558
116,641
184,202
57%
EBITDA
Rs. Mn
7,634
17,055
30,658
41,636
74,407
77%
Cash Profit from

Operations
Earnings Before Tax
Rs. Mn
4,904
14,363
28,219
40,006
73,037
Rs. Mn
(1,762)
5,527
15,832
23,455
46,784
107
%
NA
Profit After Tax
Rs. Mn
(2,051)
5,837
12,116
20,279
40,621
NA
Comments: EBITDA growth rates are close to that of customer growth rates, i.e., the company is
not achieving growth at the cost of profitability.
48

Particulars
Unit
2003
2004
2005
2006
2007
CAGR
Stockholders Equity
Rs.Mn
48,262
49,146
53,200
73,624
114,884
24%
Net Debt
Rs.Mn
32,395
42,292
41,171
41,738
42,867
7%
Capital Employed
Rs.Mn
80,657
91,438
94,371
115,362
157,750
18%
EBITDA Margin
25.0%
33.9%
37.6%
35.7%
40.4%
Net Profit Margin
-6.7%
11.6%
14.9%
17.4%
22.1%
Based on Balance
Sheet
Key Ratios
Comments: Growth in all balance sheet metrics shareholders equity, net debt and capital employed
is significantly lower than that in P&L items. This is a +ve, i.e., growth in income has not come about
simply by increasing the asset base / balance sheet.
49

Particulars
Unit
2003
2004
2005
2006
2007
Key Ratios
Return on Stockholders Equity
-4.2%
12.0%
23.7%
32.0%
43.1%
Return on Capital Employed
0.9%
9.9%
15.7%
21.5%
31.6%
Net Debt to EBITDA
Times
4.24
2.48
1.34
1.00
0.58
Interest Coverage Ratio
Times
2.44
5.24
9.65
17.45
26.47
Rs.
26.04
26.52
28.70
38.87
60.59
Times
0.67
0.86
0.77
0.57
0.37
Rs.
(1.11)
3.15
6.53
10.78
21.43
Book Value per Equity Share

Net Debt to Stockholders
Equity
Earnings per Share (Basic)
50

This part of the MD&A ties in very closely with the financial statements. These sections typically
contains an overview of financial performance as well as elements such as:
Funding plans for capital expenditure (capex)
Companies generally talk about the capex incurred in the previous year as well as capex
requirements for the current year. It is important to understand whether this will involve raising debt /
equity or both. It is also necessary to try and gauge the market implications of a companys funding
plans i.e. the potential reaction from the stock & bond markets. One can also try and link the
amount mentioned in this part of the MD&A with those in the cash flow statement to try and gauge
what portion of the funding plans can be covered by ploughing back operational cash flows.
51

Share buybacks
Several companies have share buyback programmes in place. These prevent EPS (Earnings Per
Share) dilution due to stock issuance from stock option grants as well as help to maintain a targeted
capital structure. The CS/MD&A typically talk about the continuation / discontinuation of these
programmes as well as the resultant funding implications.
52

Dividends
This section gives an insight into a companys attitude towards dividends. Some companies pay a
large proportion of their net income as dividends. Others may choose to re-invest dividends in their
businesses (i.e. have a low dividend payout), in the belief that shareholders would not earn similar
results by receiving dividends and then re-investing them elsewhere.
53

Financial strategies: An Example
Chairmans Message of Rio Tinto, a global mining company, expressly talks about its capex plans,
dividends and share buyback in relation to cash from operations in its 2006 Annual Report. In cases
where companies do not link up funding requirements with their operational cash flows, it will be
necessary for the analyst to do so.
Excerpts from Rio Tinto Global Mining Company Annual Report 2006-07
The final dividend declared for 2006 of 64 US cents per share brings the total for 2006 to 104 US
cents, an increase of 30%. We have a long standing policy of progressive dividend delivery and
maintaining it remains a priority. In addition, our strong operational cash flows have enabled us to
return US$2.4 Billion to shareholders through the buyback of shares and the payment of US$1.5
Billion special dividend. We have recently announced, subject to market conditions, our intention
to return a further US$3 Billion to be completed by the end of 2007, while still retaining the
financial flexibility to take up growth opportunities as they arise.
54

Financial strategies: An Example
Excerpts from Rio Tinto Global Mining Company Annual Report 2006-07
Our main priority for the use of cash generated continues to be profitable investment in the
growth of the business with particular emphasis on our portfolio of economically robust projects.
Our capital investment grew from US$2.5 Billion in 2005 to US$3.9 Billion in 2006. Our pipeline
of project opportunities will see this grow to around US$5.0 Billion in 2007.
55

Mergers and Acquisitions (M&A)
The Chairman's statement and MD&A typically cover acquisitions (if any). The analyst will have to
thoroughly understand the following:
Investment in acquisition
Synergies
Logic and reasoning behind the acquisitions
Market and operational reach behind the acquisitions
56

Mergers and Acquisitions: An Example
Excerpts from Tata Steels Acquisition of Corus plc (UK). Annual Report 2006-07
The Year for Tata Steel

This has been a momentous year for Tata Steel. It has been a year of record performance and
growth with significant progress in the expansion programme to raise capacity from 5 to 6.8
million tonnes in Jamshedpur. But undoubtedly the most notable event during the year was the
companys public offer to acquire 100% of the shares of Corus Group plc, a 21 million tonne
capacity steel producer with plants in the United Kingdom and the Netherlands. Together, Tata
Steel and Corus will be a 30 million tonne steel enterprise, (after completion of the expansion
programme in Jamshedpur), and the sixth largest steel company in the world, with operations in
four continents.
57

The acquisition of Corus has transformed Tata Steel from a domestic steel producer to an
international steel company with global scale. It is a fitting tribute to the vision of our Founder,
Jamsetji N. Tata, that this very major transformation has taken place in the centenary year of the
Companys operations.
The synergies that will be derived from Tata Steel and Corus coming together will be of
tremendous strategic value to both organisations. The leveraging of low cost intermediate
products from India with further processing at Corus to produce high-end finished products,
along with several operation-related initiatives will improve the competitiveness of Corus in the
European markets while India will benefit from high-value, sophisticated finished products
developed in Corus R&D facilities.
58

Further, the combined entity will foster cross fertilisation of Research & Development
personnel, and domain expertise in the automotive, packaging and construction sectors, in
addition to the exchange of technology, best practices and expertise. An integration team is
in place, which will drive the operations as one single virtual enterprise. The enthusiasm,
support and acceptance of the acquisition by employees on both sides has been very
heartening.
Comments: The company expects cross-fertilisation of R&D activated as well as improved expertise
in areas sectors such as auto, packaging and construction.
59

Acquisition of Corus Group plc, UK
Tata Steels investment in Corus Group plc is consistent with the Companys stated
objective of growth and globalisation.
In keeping with its vision of becoming a truly global player and creating a 50 million tonne
steel capacity by 2015, through both organic and inorganic growth, the Company had been
examining various opportunities.
60

The process started with the acquisition of NatSteel Asia Pte. Ltd. (Singapore) in 2005 and
Tata Steel (Thailand) Public Co. Ltd. (erstwhile Millennium Steel) in 2006, the planned
brownfield expansion in Jamshedpur and the long-term green-field projects in Orissa,
Chhattisgarh and Jharkhand.
Comments: The Corus acquisition is not a one-off event. It has been preceded by others and is part
of the companys overall strategy to become a global player. Note that the companys final targeted
capacity of 50 million tonnes by 2015 is still much above the Tata Steel+Corus combine. Therefore,
further acquisitions cannot be ruled out.
61

Corus Financing
On 2nd April, 2007, Tata Steel completed its acquisition of Corus Group plc (Corus) at a
price of 608p per ordinary share in cash. The net funding requirement for the acquisition of
Corus was Rs. 56,150 crores (USD 12.90 billion). The acquisition was initially funded by a
cash contribution by Tata Steel of Rs. 11,750 crores (USD 2.7 billion) (funded by a mixture
of its own cash resources and syndicate loans) to Tata Steel Asia Holdings Pte. Ltd.
(TSAH). TSAH raised bridge loans of Rs. 10,900 crores (USD 2.5 billion) and Tulip UK
Holdings raised a mezzanine loan of Rs. 2,600 crores (USD 0.6 billion) which was invested
by way of equity in Tata Steel UK Ltd.
Comments: The total cost of the acquisition is USD12.9 billion. One point to note is the large size
of the acquisition in relation to the companys size (compare capacities pre and post Corus). A
larger question is: is this the right price for acquisition?
62

To finance the balance of the consideration due under the acquisition, Tata Steel UK Ltd.
(through its wholly owned subsidiary, Tulip Finance Netherlands BV) raised senior debts of
Rs. 17,400 crores (USD 4.0 billion) and Mezzanine bridge of Rs. 13,500 cores (USD 3.1
billion). These loans were raised without recourse to Tata Steel.
The combination of Tata Steel and Corus will enable Corus to move towards the next level
of strategic transformation through access to low cost steel production and high growth
markets in Asia.
63

The transaction creates the sixth largest steel producer in the world and Corus can now
grow and compete on a global scale, whilst still pursuing its existing plans for Western
Europe. Both companies also share a set of common, core values and the same approach
to business performance. A similar commitment to continuous improvement augurs well for
the future of the enlarged Group.
64

I. Strategic Rationale for acquisition of Corus
The Companys investment in Corus Group plc (which was completed in April 2007) is
consistent with the Companys stated objective of growth and globalisation. Post Corus
acquisition, Tata Steel is the sixth largest steel producing company in the world with a steel
making capacity (crude) of around 28 million tonnes.
Corus is Europes second largest and the ninth largest steel producer in the world and
produced 18.3 million tonnes of crude steel in 2006. Corus has crude steel production
capacity of 21.2 million tonnes in UK and Netherlands. Corus also has downstream
manufacturing facilities in Germany, France, Norway and Belgium.
65

In the UK, Corus has a 14.4 million tonne capacity - Port Talbot (4.7 million tonnes),
Scunthorpe (4.5 million tonnes), Teesside (3.9 million tonnes) and Rotherham (1.3 million
tonnes). The Ijmuiden plant in Netherlands has a crude steel capacity of 6.8 million tonnes
and is also one of the lowest cost producers of steel in the Western Europe.
Corus is one of the leading suppliers of steel to the automotive, construction, packaging,
engineering, rail, aerospace, metal goods, and oil and gas industries. Corus has a strong
Research and Development capability which focuses on continuous improvement in
manufacturing processes and development of high value added steel products.
66

Through the acquisition of Corus, Tata Steel would also have a presence in the developed
markets of Europe, have access to the strong product portfolio and research and
development facilities in Corus. The combined businesses of Tata Steel and Corus will be
driven by a common vision and strategy to cater to the requirements of the global
customers from its worldwide operations. The steel industry is also undergoing structural
changes and increased consolidation in the steel sector is likely to result in a re-rating of the
industry in the near future.
Comments:
Geographical reach will increase (through Corus presence in European

markets) and product range will also increase.
A larger question is: is this the right strategy for Tata Steel?
67

II. Valuation of Corus Group plc
The Enterprise Value (EV) of the Corus acquisition was around Rs. 59,850 crores (USD
13.75 billion), which includes its continuing debt of Rs. 3,700 crores (USD 0.85 billion). The
Enterprise Value/tonne of the Corus acquisition works out to around Rs. 32,700/tonne (USD
751/tonne) based on Corus actual crude steel production of 18.3 million tonnes in 2006 and
Rs. 28,250/ tonne (USD 649/tonne) based on its crude steel capacity.
68

III. Integration of overseas acquisitions
Integration of Corus and Tata Steel
The Integration philosophy of the Tata Steel Corus combine is premised on the strong
cultural fit and corporate governance practices of the two companies. To facilitate
integration and create a virtual organisation across the combined businesses, a Strategic
and Integration Committee (SIC) has been formed with Mr. Ratan Tata as the Chairman, Mr.
B. Muthuraman, Mr. Philippe Varin, Dr. T. Mukherjee, Mr. Rauke Henstra, Mr. Koushik
Chatterjee and Mr. David Lloyd as members.
69

The SIC will develop the common agenda for the combined Group that will focus on
continuous improvement, sharing of best practices, manufacturing excellence, cross
fertilization of research and development capabilities, rationalisation of costs across the
businesses and create the foundation to pursue growth in the future.
A structured approach has been undertaken and the entire integration is being co-ordinated
by a Program Office formed for the above purpose. Several teams having representations
from both companies have already been set up to handle the integration and strategic work
streams.
70

Checklist of Important Learnings
The following checklist of questions will serve to organize your thoughts when you go through a
companys CS & MD&A. Note that it is not exhaustive, as each company has analytical points that
will be specific to it. Even so, using the following checklist as a guide will help you in your analysis,
especially in the initial stages.
1.What has the company achieved in the previous year (in terms of operational performance)?
2.What are the goals for the current and future years?
3.What are the strategies that the company proposes to use in order to achieve these goals?
71

4.
Which products / divisions have outperformed / underperformed? What are the reasons behind
this?
5.
How have volumes and prices moved over the past year?
6.
What are the prospects for the industry in which the company operates?
7.
What are the overall economic prospects for the countries in which the company operates? How
are these likely to impact the companys performance?
72

8.
What are the companys key success factors? Are they likely to persist in the medium term?
9.
What have you learned after calculating CAGRs for key numbers such as sales, EBITDA, net
income, total assets and shareholders equity (this includes reserves)?
10. What are the key opportunities and threats facing the company and how does it propose to
address these?
11. What are the companys growth strategies?
73

12. What are its plans with respect to dividends?
13. Are there any share buyback plans? Is the company proposing to continue the same?
14. What are its capex plans and the resultant funding implications?
15. Are there any inconsistencies between the CS / MD&A and the financial statements?
16. Are there any key areas that are left unanswered by these two sections?
74
Financial statements (or financial reports) are formal records of a businesses' financial activities.
Financial statements provide an overview of a business' financial condition in both short and long
term. There are three basic financial statements:
Financial
Statements
Income
Statement
Balance Sheet
Cash Flow
Statement
75
For large corporations, these statements are often

complex and include an extensive set of notes to the
financial statements and management discussion and
analysis. The notes typically describe items on the
balance sheet, income statement and cash flow
statement in further detail. Notes to financial
statements are considered an integral part of the
financial statements.
76

Notes provide supplementary information to consolidated financial statements and are considered
an integral part of any Annual Report. These must be read as thoroughly as the financial
statements. Notes can be divided into three major categories as shown below:
Notes to
Consolidated
Statements
Accounting
Policies
Explanatory
Notes
Supplementary
Information
77

Accounting Policies
These provide an overview of major accounting principles used by a company in the preparation of
its financial statements. A few examples are given below.
Excerpts from Microsoft Corporation Annual Report 2007
Note 1 Accounting Policies
Accounting Principles
The financial statements and accompanying notes are prepared in accordance with
accounting principles generally accepted in the United States of America.
78

Accounting Policies: Example
Principles Of Consolidation: The financial statements include the accounts of Microsoft
Corporation and its subsidiaries. Intercompany transactions and balances have been
eliminated. Equity investments in which we exercise significant influence but do not control
and are not the primary beneficiary are accounted for using the equity method. Investments
in which we are not able to exercise significant influence over the investee and which do not
have readily determinable fair values are accounted for under the cost method.
79

Accounting Policies: Example
Foreign Currencies: Assets and liabilities recorded in foreign currencies are translated at
the exchange rate on the balance sheet date. Revenue and expenses are translated at
average rates of exchange prevailing during the year. Translation adjustments resulting from
this process are charged or credited to Other Comprehensive Income (OCI).
80

Explanatory Notes
These offer a detailed overview on a number of supplementary financial metrics, including:
Fixed assets
Shareholders equity
Stock options
Taxes
Financing and debt
Employee benefit plans
Leases
81

Explanatory Notes: Example
Excerpts from Note 14 Employee Stock and Savings Plans - Microsoft Corporation Annual Report
2007
Employee Stock Purchase Plan. We have an employee stock purchase plan for all
eligible employees. Compensation expense for the employee stock purchase plan is
recognized in accordance with SFAS No. 123(R). Shares of our common stock may be
purchased by employees at three-month intervals at 90% of the fair market value on the
last day of each three-month period. Employees may purchase shares having a value not
exceeding 15% of their gross compensation during an offering period. Employees
purchased the following shares:
82

Explanatory Notes: Example
Excerpts from Note 14 Employee Stock and Savings Plans - Microsoft Corporation Annual Report
2007
(Shares in millions)
2007
2006
2005
Shares purchased
17
17
16
Average price per share
$25.36
$23.02
$23.33
At June 30, 2007, 125 million shares were reserved for future issuance.
83

Supplementary Information
Supplementary information notes provide additional details about a companys operations.
example, for an oil & gas company, it may provide:
For
A listing of reserves
Unit sales by product line
84
Report of Managements Responsibilities

Major responsibilities of management include:
Responsibilities of
Management
Preparing
companys
financial
statements and
reports
Companys
internal financial
controls
Allowing company directors and

independent auditors to carry out
their respective roles in assuring the
accuracy of the companys financial
statements.
85
An example
Report of Management on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over
financial reporting for the company. Internal control over financial reporting is a process to provide
reasonable assurance regarding the reliability of our financial reporting for external purposes in
accordance with accounting principles generally accepted in the United States of America. Internal
control over financial reporting includes maintaining records that in reasonable detail accurately and
fairly reflect our transactions; providing reasonable assurance that transactions are recorded as
necessary for preparation of our financial statements; providing reasonable assurance that receipts
and expenditures of company assets are made in accordance with management authorization; and
providing reasonable assurance that unauthorized acquisition, use or disposition of company assets
that could have a material effect on our financial statements would be prevented or detected on a
timely basis.
86
An example
Because of its inherent limitations, internal control over financial reporting is not intended to
provide absolute assurance that a misstatement of our financial statements would be prevented
or detected.
Management conducted an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation,
management concluded that the companys internal control over financial reporting was effective
as of June 30, 2007. There were no changes in our internal control over financial reporting during
the quarter ended June 30, 2007 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting. Deloitte & Touche LLP has audited
this assessment of our internal control over financial reporting.
87
Risk Factors
An example
Excerpts from Microsoft Corporation Form 10-K 2007
Our operations and financial results are subject to various risks and uncertainties, including those
described below, that could adversely affect our business, financial condition, results of operations,
cash flows, and trading price of our common stock.
Challenges to our business model may reduce our revenues and operating margins.
We face intense competition.
We may not be able to adequately protect our intellectual property rights.
Third parties may claim we infringe their intellectual property rights.
88
Risk Factors
An example
We may not be able to protect our source code from copying if there is an unauthorized disclosure
of source code.
Security vulnerabilities in our products could lead to reduced revenues or to liability claims.
We are subject to government litigation and regulatory activity that affects how we design and
market our products.
Our business depends largely on our ability to attract and retain talented employees.
Delays in product development schedules may adversely affect our revenues.
89
Risk Factors
An example
We make significant investments in new products and services that may not be profitable.
Adverse economic conditions may harm our business.
We have claims and lawsuits against us that may result in adverse outcomes.
We may have additional tax liabilities.
Our consumer hardware products may experience quality or supply problems.
90
Risk Factors
An example
If our goodwill or amortizable intangible assets become impaired we may be required to record a
significant charge to earnings.
We operate a global business that exposes us to additional risks.
Catastrophic events or geo-political conditions may disrupt our business.
Acquisitions and joint ventures may have an adverse effect on our business.
Improper disclosure of personal data could result in liability and harm our reputation.
Other risks that may affect our business.
91
Legal Proceedings
An example
See Note 17 Contingencies of the Notes to Financial Statements (Part II, Item 8) for information
about legal proceedings in which we are involved.
Government competition law matters.
Antitrust, unfair competition, and overcharge class actions.
Other antitrust litigation and claims.
Patent and intellectual property claims.
Other.
92
Auditors Report
An example
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Microsoft Corporation:
We have audited the accompanying consolidated balance sheets of Microsoft Corporation and
subsidiaries (the Company) as of June 30, 2007 and 2006, and the related consolidated
statements of income, cash flows, and stockholders equity for each of the three years in the period
ended June 30, 2007. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements based on our
audits.
93
Auditors Report
An example
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
94
Auditors Report
An example
In our opinion, such consolidated financial statements present fairly, in all material respects, the
financial position of Microsoft Corporation and subsidiaries as of June 30, 2007 and 2006, and the
results of their operations and their cash flows for each of the three years in the period ended
June 30, 2007, in conformity with accounting principles generally accepted in the United States of
America.
95
Auditor Report
An example
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control over
financial reporting as of June 30, 2007, based on the criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated August 3, 2007, expressed an unqualified opinion on
management's assessment of the effectiveness of the Companys internal control over financial
reporting and an unqualified opinion on the effectiveness of the Company's internal control over
financial reporting.
/s/ DELOITTE & TOUCHE LLP
Seattle, Washington
August 3, 2007
96
Details of Directors and Officers

This section lists the directors and executive officers of the company and their past and current
professional affiliations. Example of Microsoft Corporation is given below.
An example
DIRECTORS
William H. Gates III0
Chairman of the Board,
Microsoft Corporation
Raymond V.
Gilmartin4,5
Former Chairman,
President, CEO,
Merck & Co., Inc.
Charles H. Noski1,3
Former Vice Chairman,
AT&T Corporation
Steven A. Ballmer0
Chief Executive Officer,
Reed Hastings3
Founder, Chairman and
Chief Executive Officer,
Netflix, Inc.
Dr. Helmut Panke2,5

Former Chairman of the
Board of Management,
BMW AG
97
An example
James I. Cash Jr.,

PhD.1,2,5
Former James E. Robison
Professor,
Harvard Business School
David F. Marquardt3,4
General Partner,
August Capital
Jon A. Shirley3
Former President,
Chief Operating Officer,
Dina Dublon1,2,3
Former Chief Financial
Officer,
JPMorgan Chase
Board Committees
1. Audit Committee
2. Compensation Committee
3. Finance Committee
4.
5.
Governance and Nominating Committee

Antitrust Compliance Committee
98
An example:
Executive Officers
William H. Gates III
Chairman of the Board
Lisa E. Brummel
Senior Vice President,
Human Resources
Jeffrey S. Raikes
President,
Microsoft Business
Division
Steven A. Ballmer
Chief Executive Officer
Kevin R. Johnson
President,
Platforms & Services
Division
Bradford L. Smith
Senior Vice President,
General Counsel and
Secretary
Robert J. (Robbie)
Bach
President,
Entertainment and
Devices Division
Christopher P. Liddell
Senior Vice President
and Chief Financial
Officer
B. Kevin Turner
Chief Operating Officer
99
Thank You.
100

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FINANCIAL REPORTING AND ANALYSIS

Reading the Annual

Importance of Annual Reports

Utility of information in MD&A

Notes to Consolidated Statements

Structure of Annual Reports

Chairmans Statement / Letter to stockholders

The Income Statement

Structure of Annual Reports

Structure of Annual Reports

Birds Eye View

Elaborates the above and

Structure of Annual Reports

Structure of Annual Reports

Contain both facts

Contain only facts

Structure of Annual Reports

Structure of Annual Reports

Chairmans Statement (CS)

Chairmans Statement (CS)

Chairmans Statement (CS)

Chairmans Statement (CS)

Salient point: Continued good performance of the economy.

Chairmans Statement (CS)

Chairmans Statement (CS)

Salient point: Continued good performance of the company.

Chairmans Statement (CS)

Chairmans Statement (CS)

Salient point: Focus on increasing geographic footprint.

Chairmans Statement (CS)

Chairmans Statement (CS)

Chairmans Statement (CS)

Chairmans Statement (CS)

Chairmans Statement (CS)

Chairmans Statement (CS)

An example: Tata Motors Limited 62nd Annual Report: 2006-07

(In millions, except per share data)

Diluted earnings per share

(In millions, except per share data)

Cash and short-term investments

Cash dividend declared per share

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

It provides information on industry size and growth prospects.

Management Discussion and Analysis

MARICO Limited Growth Strategy - Sustained Growth

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Management Discussion and Analysis

Car penetration in India

Increase in disposable income

Inflation / hardening of interest rates

Large two-wheeler parc

Growing consumer culture

Growing consumer awareness

Growth of Mass Transport Systems